Republic Services Inc (RSG) 2006 Q4 法說會逐字稿

Good morning and welcome to the fourth quarter conference call for investors in Republic Services. Republic is traded in the New York Stock Exchange under the symbol RSG. Your host this morning is Republic Chairman and CEO, Jim O'Connor. Today's call is being recorded. [OPERATOR INSTRUCTIONS]

At this time it is my pleasure to turn the call over to Mr. O'Connor. Good morning, Mr. O'Connor.

Good morning and welcome. Thank you for joining us. This is Jim O'Connor and I would like to welcome everyone to Republic Services fourth quarter conference call. This morning Tod Holmes, our Chief Financial Officer; and Ed Lang, our Treasurer are joining me as we discuss our fourth quarter performance and our 2007 financial guidance. I'd like to take a moment to remind everyone that some of the information we will discuss with you today contains forward-looking statements which involve risks and uncertainties and may be materially different from actual results. Our SEC filings discuss factors that could cause actual results to differ materially from expectations.

Additionally, the material that we discuss today is time sensitive. If in the future you listen to a rebroadcast or a recording of this conference call you should be sensitive to the date of the original call, which is February 2, 2007. Please note that this call is the property of Republic Services, Incorporated. Any redistribution, retransmission, or rebroadcast of this call in any form without the expressed written consent of Republic Services is strictly prohibited.

Republic's performance in the fourth quarter and full year has exceeded expectations. Specifically during the fourth quarter Republic has had revenue growth of 3.8% to $766 million. Republic's full year revenue exceeded $3 billion for the first time since going public. We achieved internal growth of 3.6% with 4.4% of price improvement and a negative 0.8 of a percent volume growth. Our fourth quarter volume growth comparison was impacted by the revenue associated with the hurricane cleanup in 2005.

As previously discussed Republic has approximately $13 million of revenue associated with the cleanup activity in the fourth quarter of 2005. We expanded operating margins by 130 basis points to 16.9% in the quarter, and by 20 basis points for the full year. Our pricing discipline has reversed margin erosion that we experienced in recent years. Price increases are offsetting higher equipment, energy, insurance, and labor costs that we have experienced during the past several years. Our pricing decision tools have assisted in our broader general price increases, utilization of fuel surcharges, and improved returns on municipal agreements. Within our landfill business our core price was up approximately 2.1% in the quarter. As we have discussed in previous calls landfill pricing will continue to improve as third-party disposal agreements roll off.

We'll continue to focus on all components impacting our cost structure such as safety, maintenance, labor productivity, system standardization and training our ability to secure improved pricing is the key driver to higher margins and returns. Republic has had a number of significant achievements including our free cash flow for the year was $286 million. During the quarter, we continued to return cash flow to our shareholders. In the fourth quarter we repurchased approximately 1.8 million shares of our stock for $74.3 million. During 2006 Republic repurchased approximately 12.2 million shares for $492 million.

For calendar year 2007 the Board has approved $250 million for share repurchase. At today's stock price we will buy back about 4.5% of our outstanding shares. Since the inception of our share repurchase program in July 2000 we have bought over -- approximately 64 million shares of Republic stock for $1.8 billion. Our earnings per share for the fourth quarter was $0.51, which was an increase of 19% compared to the fourth quarter 2005. Our franchise agreement for the city of Henderson, Nevada, has been extended to the year 2025. Republic has a long-term commitment to service the municipal solid waste needs of residences and businesses in Clark County, Nevada. Our Board of Directors has approved a 3 for 2 stock split. We believe that this action will improve our trading liquidity and make our stock more accessible for individual investors. At this time I would like to turn the call over to Tod Holmes for our financial review of the fourth quarter. Tod?

Thank you Jim. I'll begin may review of the Company's financial results by discussing the fourth quarter revenue. The fourth quarter of 2006 revenue rose 3.8% to 766 million from 738 million last year. Internal growth was 3.6%, of which 2.8 was from core operations, and within core operations, 3.6 from price and 0.8% decline in volume. Our core volume was reduced by approximately 180 basis points as a result of hurricane-related revenue recorded in the fourth quarter of 2005.

Core volume also includes about $6 million of revenue associated with Republic Services assuming from a subcontractor the responsibility for hauling Toronto waste, the net of these two would be, primarily due to the hurricane, a negative 100 basis points in volume. Total price growth was 4.4% with 3.6% from core price, 0.2% from fuel surcharges, 0.4% from environmental fees, and 0.2% from commodities. During the quarter, Republic continued to benefit from our ongoing price increase strategy in all lines of businesses. Price growth remains a key initiative in 2007. Acquisitions and taxes amounted to the remaining 0.2% of growth in our revenue.

Now, our provision for income taxes I want to discuss briefly. This is something that's changed. The Company's effective tax rate for the three months ended December 31, 2006, was 38.5%. We expect our effective tax rate for fiscal 2007 to be at that slightly higher 38.5% rate, due to the mix of state taxes and some states which have slightly higher tax rates. This expected effective tax rate and the EPS guidance we have provided excludes the impact of the implementation in the first quarter of 2007 of FIN 48 on income taxes. The implementation of that pronouncement we do not believe will be material to our guidance, or to the effective tax rate.

Fourth quarter year-over-year operating margin. Year-over-year the operating margins increased by 130 basis points from 15.6% to 16.9%. Key components of our year-over-year margin change are as follows. Fuel, 10 basis points. Landfill operating expense was a negative 100 basis points. Risk and insurance cost was a negative 20 basis points. Our labor, disposal, and subcontracting costs were a positive 200 basis points. DD&A was a positive 80 basis points. SG&A was a negative 40 basis points, for a net benefit of 130 basis points.

I'll briefly comment on these components of year-over-year margin change. First, fuel. Fuel currently is approximately 5.6% of revenue during the fourth quarter of 2006. Our average wholesale price per gallon decreased by about 6% from $2.60 in Q4 of '05, to $2.45 in Q4 of '06. Current fuel prices are approximately $2.33, probably another 5% decline. So it's a favorable situation as we go into the first quarter of 2007. Second, landfill operating expense. During the fourth quarter of 2006 the Company incurred additional costs at one of its active landfills associated with remediation for waste that was deposited during the mid 1990s and higher leachate costs.

Third, risk and health insurance. Insurance expense during the fourth quarter of 2006 was higher than the third quarter of 2005 due to claims development. Risk expense for fiscal 2006 was approximately 5.4% of revenue, versus 5.6% in 2005. Looking forward to 2007, we believe that risk insurance as a percentage of revenue will be in the range of 5 to 5.5%. Fourth, labor disposal and subcontracting costs. This is our largest cost category to which the impact of improved pricing is clearly visible. Improved pricing in all lines of business, a change in mix of revenue, and continued focus on productivity improvements resulted in a margin benefit here. We also benefited from higher costs experienced during the fourth quarter of 2005 resulting from the hurricane cleanup that went away.

Fifth, DD&A. During the fourth quarter of 2006, the Company completed its annual review of projected costs associated with landfill capping, closure, and post-closure in accordance with SFAS 143. As a result of the review, the Company recorded a $3.1 million decrease in landfill amortization during the quarter. This is something that we have traditionally seen and compares to last year where we actually had an increase of $2.1 million in landfill amortization in the fourth quarter of '05. That was, I think, a function of higher costs that we realized for construction going forward over the life of those sites and their closure periods. Finally, SG&A. During the fourth quarter of 2006, the Company experienced higher costs associated with its 401(k) plan. That will anniversary out, as no planned design changes are contemplated for 2007, and incentive compensation program. These increases in costs were partially offset by higher year-over-year revenue. We believe that SG&A as a percentage of revenue will be approximately 10% for fiscal year 2007.

Overall, we believe that the Company could experience margin expansion in the range of 50 basis points for fiscal 2007 as a result of better pricing, the continued focus on cost control -- now this assumes no major changes in current fuel prices or in current economic conditions. Our fourth quarter operating income before DD&A. Year-over-year operating income before DD&A increased by $11.4 million, or 5.9%, from $194 million, or 26.3% in the fourth quarter 2005, to $205.4 million, or 26.8% in the fourth quarter of 2006.

Next, I'll discuss free cash flow. Free cash flow for the quarter of 2006 was $127 million. This is based upon cash provided by operating activities of $221 million, less purchases of property and equipment of $95 million, plus the proceeds from the sale of property of $1 million. And again, that equals the positive free cash flow of $127 million.

Free cash flow for the 12 months ended December 31, 2006 that you see on the financial statements was $203 million. This is based upon cash provided by operating activities of $522 million less purchases -- gross purchases of property and equipment of $338 million, plus the proceeds from the sale of property and equipment of $19 million. Again, that's the $203 million. But I need to caution the readers of our financial statements that our free cash flow for the 12 months ended December 31, 2006, was abnormally low because it was impacted by $83 million of federal income tax payments related to fiscal 2005 that were deferred until February of '06 as the result of hurricane Katrina. After normalizing for this item, free cash flow for the 12 months ended December 31, 2006 was $286 million, and that was consistent with our more recent guidance and substantially above the initial guidance at the beginning of '06.

Items impacting cash balances, during the fourth quarter, as Jim indicated, we purchased 1.8 million shares of our stock for $74 million at about $41.51 a share. And our actual share count at December 31, 2006, was 130 million shares. Republic's balance sheet remains very strong. At December 31, our accounts receivable balance was $294 million, and our day sales outstanding was 34 days. Net debt is 1.430 billion up from 1.173 billion at December 31, 2005. Consistent with our cash flow performance and previous guidance our net debt to total capitalization at December 31, 2006, is approximately 50%. Now I will turn the call back to Jim O'Connor.

Thank you, Tod. We recently concluded our 2007 business planning process. Republic will continue to focus on recovering past cost increases to improve pricing. Our business objectives are centered on improving our market position, standardizing of significant business processes, and rationalizing our cost structure. Through our pricing and cost containment initiatives we expect operating margins to expand by approximately 50 basis points. Our financial targets for 2007 are we expect to generate $315 million of free cash. Our free cash flow will exceed 100% of net income. Free cash flow will be returned to our shareholders through share repurchase and dividend. Earnings per share of $2.25 to $2.28 before the stock split. Internal growth of approximately 4 to 4.5% with 3 to 3.5% from price increases. 2007 capital spending will be approximately 310 million. And Republic will continue to maintain a fleet age of approximately 6.5 years.

I would like to thank all the employees of Republic Services for their dedication and hard work which resulted in a record financial performance in the quarter and the year. The team would like to also thank our Lee Chief Twyford, our Chief Financial -- our Chief -- sorry about that Tod, -- the Republic team would like to thank Lee Twyford, our Chief Information Officer who is retiring. Lee has been with Republic from the start and has guided our organization and its systems development department. Lee's successor, [Bill Hallin] has recently joined Republic and we look forward to his leadership of our talented IT organization. At this time, Operator, I would like to open the call for questions.

[OPERATOR INSTRUCTIONS] The first question is from Shannon Mikus of Credit Suisse.

Would you mind repeating what was going on with core volumes in the fourth quarter of last year with regards to the hurricane related details?

Sure. We had in the fourth quarter of last year -- this is the fourth quarter of '05. The hurricanes come through south Florida, two hurricanes, Katrina and Wilma, and as a result of that, we had about maybe $13.5 million of hurricane cleanup revenue with relatively low margins that we saw in '05. And which we obviously didn't experience in '06. And that's what caused this year-over-year 180-basis-point comparable decline in margins. I'm sorry, in internal volume growth.

So can you remind me whether there was any type of in this the first quarter of '06?

In the first quarter? There might have been a little bit of carryover, but nothing material.

Okay. Thank you.

Thank you.

The next question is from Bill Fisher of Raymond James.

Good morning.

Good morning, Bill.

Jim, you gave some color on landfill pricing. I was just trying to follow-up on volumes and how they were, if they were flat in Q4, then just more on the outlook there, on like special waste if that was weak this year, any other landfill openings or closings in '07?

I think actually, special waste, in comparison to '05, was probably up a little bit. Pricing, I think we've seen some improvement, in special waste pricing. More so probably I think in the Midwest, the East, and the South. There's a little weakness in special waste pricing in the West, but for the most part, it's moving up. And as far as landfill volumes overall, they're probably, as you reflected, flat to -- from municipal deliveries, flat to declining a little bit, just because of the construction demolition market.

Okay. Then, Tod, you mentioned the leachate remediation costs on the landfill side. If I'm not forgetting, I think that's been going on for a couple quarters. Is that something that could, if those sites are closed or something, could that fall off next year? And was that 4 or $5 million or so?

Well, it was -- we first saw it in the third quarter, and then probably a little more so in the fourth quarter. It's an open site, and as we look ahead, we think that the leachate that's being created from this issue is dropping off substantially. So there may be a little bit of impact in 2007, but we believe that the bulk of it was really late third quarter, fourth quarter, maybe a little bit in the early first quarter here.

Again, this was -- again, Bill, we're required to estimate the remediation, and we, and we feel that the estimates will accommodate the remediation, so therefore there should be minimal, if any impact, in '07.

The next question is from Leone Young of Citigroup.

It sounds like what you're budgeting for fuel is basically flat, although it will probably, at least if fuel stays where it is now, turn into a bit of an advantage. I'm wondering whether you're seeing any change in behavior from your competitors or the independents with fuel dropping loss, or are they still committed as well, to price increase?

We still see pricing to be relatively strong. It's not only coming from our national competitors but from the large independents that we compete with in some of our major urban markets. So we see no change in the pricing atmosphere. We see it to still be very positive. In fact, I think one of the positives that we're experiencing, even though we're seeing a seasonal decline in construction in the fourth quarter, and we're seeing some impact from the reduction in construction due to the housing market, we're still seeing prices either stable to slightly still increasing in that particular segment of the business. So I think pricing is very rational in the sector right now and I think should remain very positive through 2007.

In fact, jumping on to that, can you elaborate a little more what you're seeing in roll off residential versus commercial, any figures you have?

I think about -- we're seeing -- if you look at some comparables, we saw a sequential decline third quarter to fourth quarter in 2004 and 2005 in the area of about 5 to 6%. And in 2006, we saw a sequential decline of about 8%. So it's about a 2% swing, and I think that's what we're seeing, is some of the effects of the housing market, and again, I think the positive here is that pricing has remained relatively strong even though volumes have dropped off a little bit.

The next question is from Corey Greendale of First Analysis.

Jim, the first question I had is factoring out the impact of last year's hurricanes and factoring out the impact of the Toronto hauling. I think volume was roughly flat, year-over-year, and then the guidance calls for volume to be up 1%. So could you just talk about the dynamics behind thinking the volume is stronger next year than it was in Q4?

Well, there's a number of factors I think that are in there, Corey. Certainly we have a very strong commercial construction market, and along with that comes the permanent roll off activity, those large compactors that are in office buildings or big box stores or distribution centers. So we see some opportunity there to build, and then in both the residential and commercial systems the normal building of activity. So this 1% growth that we're estimating is based on what we see today, it's probably a little bit less than what you're hearing from a GDP standpoint because it's taking into consideration the residential construction.

Okay. And follow-up question, just kind of a mechanical question. In the guidance, are you incorporating the fuel surcharge into your price guidance, and is it reasonable to think with diesel prices where they're at that it's possible there could actually be a negative year-over-year effect from lower contribution from fuel surcharges?

Well, the price guidance is core price, so it does not include fuel surcharge. If you looked at our third quarter, we had 140 basis points of fuel surcharge. And in the fourth quarter we only had 20 basis points of fuel surcharge. So I guess this goes to an earlier question on the impact of fuel surcharge on pricing -- or fuel on pricing. I think that the industry has pretty well separated core pricing from fuel, and as a result, we feel very comfortable with this 3 to 3.5% core pricing, which, by the way, is consistent with '06. '05, we're about 2.7% price, core. '06, we did 3.4% core price. We are holding it at, we believe, at that level, which gives rise to substantial margin expansion.

The next question is from Kevin Monroe of Thomas Weisel Partners.

Good morning.

Good morning, Kevin.

Questions along -- on the volume as well. You guys, even in '01 and '02, had better than 1% volume growth, and I would think the economy is probably in better shape than it was back then. So what's giving maybe the conservatism on the volume growth? And in light of that conservatism, you've had a very good year for pricing in '06 but you have a very strong volume environment. So in what's potentially a lower volume environment do you think the pricing still stays up?

Let me say something, then Jim can -- he's got probably some additional comments. If you looked at our core volume growth for 2006, it was 1.6%. Okay? And one thing -- we reported for the full year 2.4% core volume growth, but included in there was Canadian transportation contract that we picked up and took over, and that was essentially doing the hauling--.

It was reclass due to the contract. The way the contract was--.

Was written, right. So we had to report the revenue and then the expense, so just grossed up our P&L a little bit. Yes, I think that's the primary driver. Absent that, we'd be at about 1.6%.

Well, and I guess the other thing I would say to you, Kevin, is that, we did have out in the San Francisco Bay area an anticipated closure of our West County -- Contra Costa County landfill, which we had built a transfer station on and now are moving that material over to Potrero Hills, which is a long life site and obviously because of that additional cost of transportation we did lose some volume. That's some of our reason for our sequential volume decline, and that will carry forward into 2000, and on top of that we are going to see still, I think, carry-over impact of the construction, residential construction business into 2007. So I think all of those kind of relate to why we look at the guidance number to be about 1%, and we feel that's a realistic expectation for the Company.

Thank you.

The next question is from Brian Butler of FBR.

Good morning.

Good morning.

Question on pricing just one more time. When you look at the '07 outlook, what are some of the hurdles that are out there to accomplish that kind of pricing of 3, 3.5, if any, and are those internal or more market related?

I think it's just a matter of having the organization remain focused. We recognize that margin improvement is going to significantly come from our ability to price reasonably in the marketplace. I think our organization is well trained. Mike Cordesman, our President and Chief Operating Officer, and Jerry Clark, our Corporate Controller, as well as a number of other people have designed and improved on a number of tools that the field utilizes in that process, and we remain focused on it. So I think if you're focused and you've got a discipline we can be successful.

Again, we've always talked to improving margins if we could get the pricing in the area of 50 to 150 basis points north of the CPI. And I think our pricing guidance reflects that. Again, discipline and I think focused and we're going to be successful.

Second question, just wonder if you could provide some color on, I guess, the commercial construction market or the nonresidential. Where do you think that is in its cycle?

Well, right now we still see it to be relatively strong. It it's a little hard for us to break out our temporary construction services between commercial and residential, but I would say it's still relatively strong, and it's indicative in our permanent industrial collection, growth. Again, when Tod talked to it earlier in our comments, that what's happening here is we're really starting to see the commercial construction turn into what I'm going to call annuity-type business where we're installing compaction equipment or open-top containers, depending on the type of customer, to customers that have long-term needs for those. Office buildings, shopping centers, distribution centers. So that part has grown very nicely, and I think we continue to see that growing as long as commercial construction continues to be strong. So that will hopefully offset whatever we're going to see in the residential construction market. We're hoping that what we're seeing in the fourth quarter, and it's a little hard to tell because of seasonality, we've bottomed out there.

Also, the American Institute of Architects came out in December with their Buildings Index, which was pretty strong. And the inquiries for new projects, it was the highest since 1995, indicating interest in bringing a lot of projects out of the ground that we haven't even seen.

The next question is from Scott Levine of JP Morgan.

Good morning.

Good morning.

A quick question regarding trends or differences in trends and pricing you're seeing in your competitive collection business versus what you anticipate for your franchise markets in 2007.

Well, our franchise markets are predominantly indexed, so they're going to move with either CPI or transportation index.

The 2.5 to 3%.

Yes, 2 to 2.5%. As far as on the competitive markets, I think we see relatively strong pricing, probably north of the CPI. We have not seen anybody backing away from those kinds of price increases. I know we're not going to, so again we still see that environment relatively strong.

Okay. And then with regard to the CapEx guidance, on a dollar basis, down a little bit from '06, is that due to the lower volume forecast? Are you seeing any change in trend with construction costs or any other factors there?

No, there's really no change in trends. Our net CapEx for 2006 was 319 million. The net CapEx in '07 is 310 million. There's really not anything appreciable. We did buy a few extra trucks in '06 in anticipation of the new emissions engines requirements, so that's probably why you see a little bit of a difference. There is one thing that I would like to point out, and that is, I think this company has reached an inflection point here where in the past our DD&A was maybe a little bit less than our capital spend, and I think going forward, I believe that while we have a very young asset base, 6.5-year average life on our trucks, and we are going to keep that 5.5 years on our frontline trucks, and our yellow iron is in good shape also, so we're not going to cut our capital spending in the future appreciably, but I think we're in position now where our DD&A is actually slightly higher than our capital spend which gives us a little bit of an additional tail wind on our cash flows.

Operator, one more question.

The last question comes from Jonathan Ellis of Merrill Lynch.

Good morning, guys.

Good morning, Jonathan.

On the volume outlook for '07, just wondering, does any portion of that include a rollover benefit from contracts initiated in '06?

Well, whatever contracts were there in '06 would -- yes, that would have been in that projection. But I guess we really don't have much rollover at all coming into the '07 period. So Tod, you--?

Yes, that was actually a factor. Somebody asked a question about '06. That was actually a factor from '05 to '06. Here in Florida we have in the fourth quarter of '05 a substantial contract that rolled into our '06 growth rates but as we're closing out '06 and moving into '07 there might be 10 basis points or 20 basis points at the most of rollover growth into '07.

Okay. Great. One follow-up just in terms of customer churn. Can you talk about what that was in the fourth quarter relative to the third quarter?

Well, again, the temporary construction market would skew some of these. If we just look at our permanent annuity work I'd say we're in the area of about 9%.

Okay.

Which has historically, I think, for the last 24 months or so been about where we've been. So which again gives some credence to the stability of the marketplaces.

Great. Thanks, guys.

Thank you. Thank you, operator, and we would like to thank everyone for joining us today. I'd like to remind everyone that the recording of this call is available today and tomorrow by calling area code 203-369-3598, and the passcode, 55645. Additionally, a recording of the call will be available on Republic's website at RepublicServices.com. Thank you for spending time with us today. Have a great day.

That concludes today's conference. You may disconnect at this time.